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Give Me Some Profit: The Scheme of Shorting Stocks

Sep 17, 2008
To begin what shorting stock is, look at this situation first. Person A owns one hundred shares of company AAA at say $20 per share. Person A then analyzes his stock to be overpriced and predicts that it will drop soon. Instead of panicking and just getting rid of his stocks to play it safe, Person A decides to make something big out of it.

He then approaches Person B who also owns one hundred shares of company AAA. He, Person A, asks to borrow Person B's one hundred shares promising to give it back in a couple of days or week, basically at some reasonable time in the future. When Person B agrees and gives his shares to Person A, Person A then sells the one hundred shares at $20 per share. Person A then gains $2000 (100 x 20) and keeps it and after about a week, the price of company AAA falls from $20 to $5 per share.

When this happens, the next move for Person A is to call his broker and tells him to buy one hundred shares of company AAA, now priced at $5 per share, so Person A spends only $500. After acquiring the said shares, he goes back to Person B and returns the shares he borrowed. Person A then gains $1500 ($2000 he got for selling the borrowed shares minus $500 Person A spent to buy the new shares to give back to Person B). This is what we can call easy money. Without any initial invest, an investor can double, even triple the worth of his or her stocks.

Plain and simple, shorting stocks is the method of borrowing someone else's stock with a promise to return it because you fell that the stock is overpriced and will fall soon, thus creating an opportunity to make a quick, large profit.

However, always remember that in the world of the stock market, everything you do can go either of two ways. In this case, it's either Person A's prediction that the stock price will fall may be true, or the exact opposite will happen. If so, this means that Person A would have to buy the new shares at a higher price and absorb all the loss. Yes, this is an easy way to double or triple the worth of stocks an investor holds, but at the same time it is as easy to loss double, triple and even more the worth of an investors stock. In other words, the potential of gain is high, but the potential of loss is unlimited.

Shorting stock is a method of gambling, which is not a safe thing to do with your investment in a company with nothing but a hunch that the price per stock will fall soon. The stock market is not a casino but it can be as ruthless, if not even more ruthless, to people who gambles like madmen. Always be careful, and analyze carefully every move you would plan to make.
About the Author
Justin DeMerchant is the founder of investorRT, stock trading brokers, and investing news where information on stocks and investing can be found.
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